CWH contract loss an ‘opportunity’

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API thinks it has a better chance of merging with Sigma second-time around following PBS reforms and a changed industry landscape

Last Friday Australian Pharmaceutical Industries Limited (API) announced that it had made a non-binding indicative proposal to acquire 100% of the shares in Sigma via a scheme of arrangement.

Following implementation of the scheme, API shareholders would own approximately 63% of the combined entity with Sigma shareholders owning the remaining 37%.

However the proposal is still subject to a number of conditions including completion of due diligence, confirmation of cost synergies, a unanimous Board recommendation and ACCC clearance.

API CEO and Managing Director Richard Vincent confirmed to the AJP that this is the second time API and Sigma have tried to merge, the first attempt being in 2006 – pre-PBS reforms.

Due to changes over the past decade he is “cautiously confident” that the merger will go ahead.

“The ACCC in recent times have been fairly hard on businesses coming together. But every set of circumstances is quite different, I think ours is quite different,” says Mr Vincent.

“[In] our previous forays into a merger, the ACCC had a very strong view back in those days that it wasn’t good for competition to have one less wholesaler. But in those days there were three wholesalers.”

Mr Vincent says there are now currently five players, if CH2 and DHL are included due to their volume.

Additionally, wholesaler discounts available to pharmacists back in 2006 are no longer available.

“Those discounts have disappeared over time. So the argument that there’s a lever there to reduce competition and drive customers towards a new merged entity is gone because the discounts are gone and PBS products have become a commodity in terms of price.”

Another reason in favour of the merger is that a much greater percentage of the PBS is now under the co-payment, he says.

“If you look at any of those products now there’s a huge amount of competition amongst the retail pharmacy chains,” says Mr Vincent.

“I think there’s good chance ACCC will approve it this time,” veteran pharmacy business consultant Bruce Annabel told AJP.

“They have tried in the past but now the market has fractured so much and with EBOS [holding over] 40% market share from 2019, it will certainly take costs out of the supply chain which is high time,” said Mr Annabel.

API says the rationale of merging the two companies is “more compelling than ever” due to government funding for the CSO remaining flat while input costs are increasing, PBS reforms continuing to drive price deflation and compress revenue, and the industry landscape remaining highly competitive with new entrants and further disruption likely.

It estimates $60 million in gross financial benefits through merging the companies, by year three of the merger.

The API merger proposal helped raise Sigma’s shares by 48% to $0.600 by 4.04pm on the day of the announcement, and API’s shares were also boosted by 9.2% to $1.605.

Sigma’s shares have been slumping since it lost its contract with Chemist Warehouse, with EBOS Group winning the tender to act as the exclusive third-party distributor to the My Chemist Group from July 2019.

Sigma’s shares dropped by 37% immediately following the announcement in July this year, and its first-half financial results revealed a 50.6% plummet in net profit after tax.

However API is confident that the loss of the contract can be turned into a positive.

“With Sigma losing their Chemist Warehouse contract, I don’t see that as a negative, I actually see that as an opportunity,” Mr Vincent told AJP.

“They’ll have latent capacity in their business and it gives us the opportunity to put two big businesses together and unlock some efficiencies and synergies and some cost savings that will come just by eliminating the duplication that exists across our two businesses.

“I think Sigma is a really efficient business and I think we are as well. But when you visit the same suburbs, the same customers every day, if you put the two businesses together there will be costs that drop out of that.

“So, it’s a chance for us to make our business bigger together and stronger together, and to realise some of those savings, so that’s really what drove [our decision to propose a merger].

“If they had continued on with their Chemist Warehouse business, there wouldn’t have been the same opportunity because we wouldn’t have been able to put our businesses together in the same distribution facilities and share transport costs.

“PBS reforms and other government regulation continues to challenge us to find ways to be more efficient, and one way is putting Sigma and API together.”

Sigma confirmed it had received the proposal and noted the “initial conclusions suggest a material value opportunity for all Sigma shareholders post a restructure of the business following the company’s decision not to renew its contract with Chemist Warehouse”.

The Sigma Board also reaffirmed its commitment towards acting in the best interests of its shareholders, which includes conducting an analysis to look into growth and cost-saving opportunities that Sigma can achieve in its own right.

However Sigma has offered to engage with API including to share commercially sensitive information subject to a non-disclosure agreement, and says it “remains ready” to continue these discussions.

API says it is seeking full engagement with Sigma and aims to deliver a binding proposal early in 2019.

If the merger does go ahead, Mr Vincent says EBOS will continue to be their prime competitor at a wholesale level.

“Obviously it’s very different at a retail level. At a retail level Chemist Warehouse is one of the main competitors to Priceline and also the other brands that would be in the stable. But at a wholesale level obviously it would be EBOS.”

See the full announcement about the proposed merger from Friday here.

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